Corporate tax reform for larger revenue

Corporate tax is now the most important revenue earner unlike indirect taxes, writes DH Pai Panandiker.

The fiscal deficit in the budget for 2006-07 may more or less conform to expectations - partly because the finance minister has been careful not to allow expenditure to run amok, and partly because the corporate sector has performed far better than expected.

Corporate tax is now the most important revenue earner. Indirect taxes, like excise and customs, which funded most of the current expenditure of the Union Government have, for the first time, been superseded by direct taxes, like corporate tax and personal income tax. In 2000-01 corporate tax contributed less than 20 per cent to the total tax collections; in the current year it will account for more than 33 per cent, if present trends are maintained.

The buoyancy in corporate tax revenue has taken place in spite of the reduction of tax rate. From 46 per cent at the time of reforms in 1991 the rate of corporate taxation was cut in stages to 35 per cent in 2000-01 and 33.7 per cent last year. It is partly this reduction in the rate of taxation that has been responsible for the faster growth of the corporate sector and larger revenues for government.

That lower tax rates generate larger tax revenues has been the experience of most countries. Between 1982 and 1999 the average corporate tax rate world wide dropped from 46 to 33 per cent while revenue from corporate income tax rose from 2.1 to 2.4 per cent of national income. A more dramatic instance is Russia. The corporate tax rate was brought down from 35 to 24 per cent in 2001, and the revenue shot up 14 per cent per year in the next three years.

It is not enough, however, merely to reduce the rate of taxation. For better effect it has to be accompanied by simplification of the tax laws. Unfortunately India has the most complex tax system contained in the 9000 pages of legislation. In the United States tax legislation takes less than 5100 pages. The complexity of tax laws has been responsible for litigation and consequently given rise to the lucrative but unproductive business of tax consultancy. Simplicity of laws makes for transparency and prompts better compliance.

One reason for complexity is the multiplicity of taxes, and exemptions and qualifications to the main provisions of law. The world over the trend now is for consolidation of different taxes paid by the corporate sector so that there is only one simple tax. As suggested in the joint Report of PricewaterhouseCoopers LLP and World Bank it is the total tax paid concept that should be the norm, in future, for corporate tax reform. That saves time for the companies and cost of collection for the government.

Until the total tax concept is finally adopted it is necessary to simplify corporate income tax by having a single rate without exemptions and qualifications. With that first step it would be possible to bring down the corporate tax rate to generate larger revenues for the Exchequer.